SEED MONEY

Seed money, or seed capital, is the financing an entrepreneur needs in the
very early stages of launching a new business. It gets its name from the
idea that early stage financing plants the seed that enables a small
business to grow. Obtaining funding is one of the most critical aspects of
starting a small business. In fact, many businesses fail or are prevented
from even starting due to a lack of capital. Although obtaining financing
can be difficult for any small business, it is particularly hard for new
ventures; since they lack a track record, potential lenders and investors
are often skeptical about their prospects for success. But the dedicated
would-be entrepreneur, if armed with a sound business plan and the
necessary skills, can usually obtain funding for his/her dream.

Many entrepreneurs approach their family, friends, and colleagues for seed
money after exhausting their own finances. Since they know the
entrepreneur, these investors are more likely to take a risk on funding a
new venture than are traditional financing sources, such as banks or
venture capital firms. "An entrepreneur needs vast quantities of
commitment and enthusiasm in the seed-capital stage, since the venture has
little else with which to entice investors," Reed Phillips III
wrote in an article for
Folio.
"Because it is almost impossible to predict how successful the
project might eventually become, the only outsiders likely to invest are
those who respect the entrepreneur's judgment and abilities. And
those are the people with whom the entrepreneur has had the longest
relationships." By "getting in on the ground floor,"
the providers of seed money hope to participate in the
entrepreneur's success and realize a healthy return as their
investment appreciates over time. Still, Phillips noted, "Risking
money in the early stages of a start-up is more like buying a lottery
ticket than making an investment. Investors know the odds are against them
and realize they may lose their entire investment."

In most cases, seed money takes the form of equity financing, so investors
receive partial ownership of the fledgling company in exchange for their
funds. As a result, it is important for the entrepreneur to take potential
investors' personalities and business reputations into
consideration when seeking seed money. Since these people will be part
owners of the company—and may insist upon having some control over
decision making—it is vital to ascertain whether their interests
and personalities are compatible with those of the entrepreneur. Once
suitable investors have been located, the entrepreneur must convince them
that the new business venture has a good chance of success. The first step
in this process is creating a formal, written business plan, including
plausible projections of income and expenses.

The entrepreneur should also have a specific purpose in mind for the seed
money. The purpose of seed capital usually involves moving the business
out of the idea stage—by building a prototype product or conducting
market research, for example—and gathering concrete evidence that
it can succeed. In this way, seed money helps the entrepreneur to prove
the merit of his or her idea in order to attract the interest of formal
investment sources.

As far as the amount of seed money the entrepreneur should try to obtain,
experts recommend targeting only what is needed to accomplish the
business's initial objectives. Given its risk, seed capital is
usually more expensive for the firm than later stage financing. Thus,
raising a small amount at a time helps the entrepreneur to preserve equity
for later financing rounds. Ideally, an arrangement can be made that links
seed money to launch financing, so the entrepreneur can go back to the
same investors for future funding needs. For example, the entrepreneur
might set goals for a successful market test of a new product. If the
goals are met, then the original investors agree to provide additional
funds for a product launch. This
approach protects the entrepreneur against the possibility of having a
successful test and then running out of money before being able to launch
the product. Even if the original investors cannot provide additional
funds directly, their vested interest may encourage them to help the
venture succeed in other ways.

There are other sources of seed money available to entrepreneurs besides
friends and family members. For example, some venture capital firms
reserve a limited amount of funds to finance new ventures or business
ideas. Since start-ups involve greater risks than established businesses,
however, the venture capital investors generally require a larger equity
position in exchange. In his book
The Entrepreneur's Guide to Preparing a Winning Business Plan and
Raising Venture Capital,
W. Keith Schilit estimated that venture capitalists providing seed money
would expect a 50 to 100 percent higher return than in a standard venture
capital arrangement. There are also nonprofit organizations dedicated to
providing seed capital for new businesses. In many cases, these
organizations will also assist the entrepreneur in creating a business
plan or marketing materials, and establishing cash flow controls or other
systems.

FURTHER READING:

Fraser, Jill Andresky. "Seeking Seed Money."
Inc.
December 1995.

Phillips, Reed III. "Raising Seed Money Is a Critical First
Step."
Folio: The Magazine for Magazine Management.
February 15, 1995.